Historically, “companies” (a term defined below) and their customers often have done business across a gap, so to speak. Product or service offerings by a company and the customers' desired product or service do not fully match. In part, this gap is a manifestation of the facts that (1) companies have an incomplete grasp of customer needs, their relative preferences and the pricing utilities customers attach to those preferences (which utilities, equating to the customer's willingness to pay, are dynamic) and (2) a company's costs, profits and inventory (which may control what it can offer on a timely basis) are also dynamic. However, it is also in major part a manifestation of the lack of information technology tools, which can close the gap. To collect dynamic customer and company data and then employ those dynamic data to close the gap is a complex technical problem.
Generally, the customer is treated as an individual and sales terms are customized only when the cost of negotiation is justified—for very large transactions. Many products and services, though, represent complex, multi-faceted offerings and customers weigh their preferences for product features differently at different times. A customer might care more about cost one day and more about availability or delivery time or warranty if queried a few days or weeks later, to use some basic trade-offs as examples. Generally, a company's product comprises many value elements, (explained later) all of which are bundled together to be sold as a single product. But, not every customer values all the aspects of a product equally or needs all. Every customer places a different value (which may be a function of time and situation) on each aspect of a product. With features bundled together in a product, companies end up either incurring costs to sell something to a customer that he does want or lose a customer because the extra undesired value elements forced the product price too high for the customer.
The underlying problem is both that customer demands are incompletely understood and that such demands can change quickly, whereas a company's productive capacity or service often does not have the same dynamic time frame and is supported by a relatively fixed (in the short term) capacity and supply chain.
As explained above, customers have varied needs and preferences and they evaluate products accordingly. In a customer's frame of mind, products with higher perceived satisfaction (utility) values generally are ranked higher than those with lower perceived utilities. Generally, products that (most customers would) rank higher are also higher priced. Therefore, customers would want to buy a higher ranked product only to the extent that the additional value and incremental price satisfies their individual utility dynamics. Many times customers cannot buy their desired product and have to content themselves with a lower-ranked product because of high price or unavailability. The price component may involve budget constraints or a perception that the higher rated product is over priced. Consider a company that sells two products A and B, where most people rank product A higher than product B and consequently or otherwise, A is also priced higher than B. What happens, when company face an excess supply of A? The situation becomes trickier when products in question are perishable in nature and of high monetary value. The company faces the dilemma of either to lower the price and face future revenue dilution, or to write off its unused capacity/excess supply for A. Advertisements and marketing campaigns can help to stimulate demand but not in the short term. In these situations, when it is difficult or not feasible to generate more demand, or even otherwise, a good solution is to upgrade the mix, or in other words, to upgrade the current customers to products rated higher than those bought currently. In the above example, there might be several customers who have bought B but would be willing to buy (or, rather switch to) A if A were offered to them at price and on terms that suit them. However, there is currently no mechanism for implementing this method in a mass market situation. In other words, there are no systems or methods available to do this optimally in a mass market situation, let alone while concurrently maximizing the benefit to the company. If the company were to have some knowledge of its customers' intentions, the company could be more exacting in its ordering, staffing and delivery. Inefficiencies thus would be reduced, revenue and profitability would be increased and the company would then be able to reduce its price to the customer while simultaneously improving profits.
The airline industry is an excellent example of one in which customer utilities vary considerably, and wherein it is appreciated that customers will pay for different levels of service. However, current ticketing and other support systems are inadequate to offer customization of service offerings commensurate with a customer's preferences and utilities.
An airline flight typically offers several levels of service through different cabins like coach (or economy), business and first. Most domestic flights in the United States have only two cabins, coach and first. There are some domestic flights that have either one cabin (by definition, all coach) or three cabins (coach, business and first). Airlines may use different names to refer to these cabins. The idea behind creating different cabins in an airplane is to provide different levels of service to its passengers, ranging from regular (economic) service in the coach cabin to most luxurious (and most expensive) level of service in the first cabin. The services differ in areas including, but not limited to, seating space and comfort, in-flight amenities and food service, priority-check-ins and luggage handling, reservation services and frequent flyer benefits. In a flight with three cabins, the first class cabin is usually the most expensive and luxurious, followed by the business class cabin and the coach class cabin. For these reasons, most airline passengers value the first or business class travel experience more than the coach class travel experience. Some first cabin fares may be as high as 5-10 times a discounted coach fare for the same Itinerary.
For simplicity, let us consider the discussion for a flight with only two cabins, first and coach. High prices for the first class cabin often result in lower demand, leading to the existence of unsold seats in the first cabin. However, airlines seldom opt to reduce the Ticket Price for first class significantly to stimulate and increase demand. Rather, they try to use unsold seats to offer upgrades to selected passengers in coach. Airlines know that many passengers in coach would love to travel in the first cabin and, hence, they try to increase customer loyalty and offer first cabin upgrades to selected coach passengers, as an added benefit. Airlines have created several programs to offer these upgrades, such as frequent flyer award upgrades, elite traveler upgrades, corporate upgrades and staff upgrades.
All these mentioned upgrade programs try to enhance the customer mix, or in other words, try to utilize the unsold first and business cabin seats to generate monetary or non-monetary benefits for the airline. However, none of these programs provides a solution that can optimally utilize all of the unsold first cabin seats. Even today, after using all sorts of upgrade programs, there are flights that still fly with empty first and business cabin seats. This occurs even though, there are coach passengers willing to pay somewhat more than the coach fare to get the otherwise empty first cabin seat. This clearly indicates that the existing upgrade programs are not very effective in tackling the situation. There are several factors contributing to this circumstance, as follows.
Varying passenger value: The relative value for travel in first class over coach varies from passenger to passenger. Even for the same passenger, the relative value changes from one trip to another (and even from one flight to another on the same trip) depending on trip duration, travel needs, budget, logistical factors and other personal or business constraints or needs.
Revenue dilution: If an airline chose to lower prices for the first cabin, it could, as a practical matter, probably fill all or nearly all of its first cabin seats, but that may cause heavy revenue dilution. Increasing the number of seats sold due to a reduction in unit Ticket Price may not necessarily increase the total ticket sales revenue. Hence, it may not be economically viable for the airlines to reduce the price for the first cabin seats.
Uncertain seat availability: It is very uncertain and difficult to predict at the outset exactly how much demand exists for first cabin seats at the given travel prices. Consequently, it is difficult for an airline to know accurately the capacity sold and unsold until the last few minutes prior to departure. The problem becomes worse as several booked first cabin passengers do not finally turn up for the flight (so-called “no shows”) or cancel their trips at the last minute.
Last-minute upgrade logistics: The exact availability of first cabin seats can be known only minutes before departure, once the airline stops taking any additional passengers for the first cabin. At that point, however, an airline doesn't have much time to find potential passengers and process upgrades to fill the unused first cabin seats. A short delay in the departure of one flight can reverberate throughout the system and delay several other flights, leading to huge costs and customer (probably much more than the additional revenue earned from additional passengers).
Similarly, one can point to examples in the airline as well as many other industries, such as hotels, car rental, cruise, special events, automobile rentals and so forth. In the airline industry, business travelers, generally, prefer morning or evening flights as compared to afternoon flights or non stop (direct) flights as compared to connecting flights. Generally, morning (or evening) flights and non stop flights may be costlier as compared to afternoon and connecting flights, respectively. These flights may depart with one or more empty seats due to inadequate demand at existing high prices.
In the hotel industry, for example, deluxe or royal suites (i.e., the higher-rated and more expensive rooms) often don't get booked as frequently as other rooms, because of inadequate demand at existing high prices. The hotels do not currently have an optimal way to deal with this situation.